When It Comes to Gold, Here’s Where the Hot Money Isn’t Going

By Brendan Conway

If you never heard the word “backwardation” until this week, this isn’t for you. In fact, let’s take it a step farther. This isn’t for just about every investor, just about all the time.

There’s an intense focus this month on the unusual state of the market for gold futures. It happens that there’s an exchange-traded fund tracking gold futures, and it performs differently versus the more common gold-in-a-vault approach of SPDR Gold Trust (GLD). By differently, I mean, worse.

Backwardation is a concern in gold markets because in theory demand for physical delivery should never outweigh supply, since the amount of available gold is a known, fixed quantity. The event is not unprecedented, as it also happened during the financial crisis of 2008 – and corrected itself the following year.

The current dislocation indicates that holders of gold futures have begun demanding delivery. But because of the large amount of leverage in the market, participants are not able to deliver on their obligations.

UBS’ Art Cashin, as things turn out, played into something of a conspiracy theory about backwardation this week. You can read all about it over at Business Insider. Suffice it to say that buying long-dated gold futures and waiting for their low prices to converge with today’s “high” price is anything but a “locked-in, riskless profit,” which is one phrase that appears in the article.

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JULY 24, 2013 6:29 A.M.

EchoVectorVEST wrote:

Although conceptually different, this sounds a great deal like it might also possibly arise from a simple and expected and larger than normal 'foreclosing processes' wreaking havoc on 'the over-leveraged and relatively decimated' resulting from getting caught (and or 'response-frozen') in a relatively historic and extensive price move to me.

In extreme adversity some people become paralyzed 'when and where' you otherwise might expect them 'to be nimble': too slow to act and relatively 'frozen in the headlights'. They then awaken to new and more dire situations than they have the energy to sustain or move. This is a 'response cohort' which can loom larger in historic, ie. irregular, movements.

See GoldPivots and "/GC GOLD FUTURES ECHOVECTOR ANALYSIS CHART UPDATES: RIGHT ON TARGET"

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As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.

Chris Dieterich has covered the U.S. stock market for The Wall Street Journal and Dow Jones Newswires. He is a graduate of Regis University and the Missouri School of Journalism.